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Question for the Money Doctors

Question submitted on Mar 14, 2014.

Question

How do I decide if I want my insurance premiums set up with pretax dollars or not.

Answer

Different types of personal insurance have different characteristics. Not knowing which you are referring to, I will focus the different types of insurance.

1. Disability Income Insurance. This is the insurance that carries the most impact with pre-tax or post-tax dollars.

If you fund on a pre-tax basis, then when you received disability income benefits, they will be taxable. If you fund on a post-tax basis, then the benefits will be tax free. It is important to have a professional evaluate ones personal facts and circumstances before anyone makes a decision in anything with a financial impact. I generally recommend that this type of insurance be secured post-tax.

Long Term Care Insurance. In my opinion, legislators recognize the risk of long term care costs, so written into the law is perhaps one of the most permissive tax benefits afforded to insurance. This can be both tax deductible and tax free at benefit. Sometimes corporations offer this as an employee benefit that the employee does not pay for or recognize as income. When it is not a corporate benefit, an individual "may" be able to deduct the insurance on form 1040 schedule A. The medical section on form 1040 schedule A has a 10 percent of adjusted gross income limitation, which most cannot qualify for. Particularly for those who are in retirement and whose home is paid for, they may not itemize deductions at all on schedule A. There is one other area to pay for long term care insurance premiums tax free. The insured, if they have an annuity or a life insurance policy with cash value can use that asset to perform a tax free 1035 exchange from the annuity or life insurance policy to pay for long term care premiums. Often times, this can be accomplished across different companies so long as they accept a 1035 exchange to pay for their long term care policy.

3. The last is life insurance. Generally, there are no meaningful ways to pay for life insurance pre-tax.


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